Question

Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2016, Rhone-Metro leased equipment to Western Soya Co. for a four-year period ending December 31, 2020, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost $280,000 to manufacture and has an expected useful life of six years. Its normal sales price is $320,273. The expected residual value of $16,000 at December 31, 2020, is not guaranteed. Equal payments under the lease are $89,000 (including $4,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2016. Collectibility of the remaining lease payments is reasonably assured, and Rhone-Metro has no material cost uncertainties. Western Soya’s incremental borrowing rate is 10%. Western Soya knows the interest rate implicit in the lease payments is 7%.

1. Show how Rhone-Metro calculated the $89,000 annual lease payments. (Enter your percentage answers as a whole number.) Unguaranteed Residual ValueTable or calculator function:PV of $1n =I (%) =Present ValueAmount to be recoveredLess: Present value of the unguaranteed residual valueAmount to be recovered through periodic lease paymentsLease PaymentsTable or calculator function:PVAD of $1n =I (%) =Lease PaymentsLease payments at the beginning of each of four yearsAdd: Executory costsLease payments including executory costs 2. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2016. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

3.	Prepare an amortization schedules describing the pattern of interest over the lease term for the lessee and the lessor.

Lessee (unguaranteed residual value excluded):

	Lease Amortization Schedule Effective Decrease in Outstanding Dec.31 Payments Interest Balance Balance 2016-2019

Lessor (unguaranteed residual value included): Same as table above but add 2020

Answer 1

PART 1:

1. Show how Rhone-Metro calculated the $89000 annual lease payments.

Let X = Amount of each annual payment (excluding executory costs)

PV of annual payments: 4 payments @ 7% = 3.6243 x X

PV of unguaranteed residual value: 4th period @ 7% = 0.7628 x $16,000 = $12205

3.6243X + $12205 = $320273

3.6243X = $308,068.

X = $308068/3.6243 = $85000(rounded off)

$85000 + $4,000 = $89,000.

PART 2:

1. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2016.

Western Soya Co. (Lessee):

1.) Leased asset      Dr           $308,068

Lease payable   Cr            $308,068

2) Lease payable                   Dr           $85000   

Prepaid lease expense Dr           $4,000

Cash                                      Cr            $89,000

Rhone-Metro (Lessor):

1)Lease receivable              Dr           $320273

Cost of goods sold           Dr           $267795 ($280,000 – $12,205)

Sales                                      Cr            $308,068 ($320273 - $12,205)

Equipment                          Cr $280,000

2) Cash DR 89,000

Executory cost payable Cr 4,000

Lease receivable Cr 85,000